Following a method when selecting investments is the best tool for long-term success. The word is that sacrificing short term profits for the sake of higher gains in the long-term is a sign of intelligence. Impatience is inherent to human nature, and not overreacting to the latest news when making investment decisions needs of a great deal of discipline. To achieve something that is so easy to say and so hard to do, we need to follow a structured analysis and decision making method that has been contrasted over time.
The AQM Method uses fundamental factors, which provide reliable mid and long-term corporate performance information, as a basis to select companies with both higher stability and growth potential and lower financial risk.
In the AQM Method there are three systematic analysis steps:
- Fundamental data growth: after screening a universe of 26,000 companies, we analyze a selection of 250-350 corporations, focusing on balance sheet, P/L and cash flow performance data covering an entire economic cycle. To avoid risks associated to financial weakness, and since we don’t place much trust in eventual recoveries that may end up translating into permanent capital losses, we reject highly indebted companies and those with negative growth ratios, even if such data is the consequence of temporary and reversible difficulties. We only keep companies with proven sustainable growth data in a sufficient and balanced number of factors to enable their managers to negotiate with ease the expansion phase in which they currently are.
- Entrance barriers: we trim down the universe to 100-200 companies, picking those that have outperformed their peers. These companies, with above average margins and growth over long periods of time usually also have intangible and hard to replicate entrance barriers, turning them into attractive and safe investments. In this phase we apply factor standardization and stochastic analysis techniques to gauge the weighting of the information provided by each factor so as to ensure a coherent comparison of companies operating in different industries and regions.
- Financial Consistency: although the quality of the information released by listed companies is nowadays more controlled than ever, we thoroughly examine the consistency of the fundamental data we analyze. This allows us to reveal attempts to tamper with or alter data; there are up to 12 different red flags that can trigger a more in-depth analysis of financial situations that, should such a comprehensive examination not be undertaken, would probably go unnoticed.
The AQM is the cornerstone of our investment process, but we don’t expect it to do all the work.
After these 3 phases, we apply 2 additional discretional analysis filters to complete the portfolio building process:
- Valuation: For some the Holy Grail of Investments, for us it is only one more reference. We feel it is impossible –and incautious– to take the target price for an investment in a company for granted when its calculation includes profit, cash flow, ratio multiples, etc. projections covering several years. We use different valuation methods, assigning different weightings to each one depending on the type of company considered, to avoid valuation biases and traps. Thus, for growth companies, all past growth is outdated and the future is unknown even to its management. In this phase we seek to match the price we pay for an investment with the subjective valuation we ourselves assign to the company, and that markets also recognize. We are not looking for bargains but for excellent companies with adequate valuations. We avoid both extremely high and extremely low valuations: we seek businesses with growth patterns that are visible and easily verifiable. At this point we focus on ensuring that price performance is consistent with actual business data, analyzing the maximum loss we can sustain, and fully comprehending the nature of the business so as to be able to immediately spot companies that may have ceased to have the quality characteristics we seek. The loss of quality or of growth potential will set off our exit decision. The price target we establish is not a static figure we aim to achieve, but rather a dynamic value that must increase in pace with the company’s growth.
- Momentum: is the pre-requisite to any investment. In addition to meeting the above requirements we ensure that market perception of the company in which we intend to invest is positive. We look for companies with above average growth and this factor should be reflected in its price, and if it is not there, we wait for the price to begin an upward trend to maximize portfolio stability. Price momentum adds a safety margin to that granted by the company’s own growth.
Once the 5 stages are completed, the turnout is a selection of assets providing quality and security that allows us to maintain the investment over a long period of time.
A clear and practical methodology gives us two advantages:
1) It allows us to take correct decisions in complex market situations, and
2) Maximizes the probability of reaching our portfolio’s return objective